Shopping centres are well versed in the art of evolution and it seems another phase of change is on the horizon.

Retail trading conditions have been strained for months, with the leg-up the government stimulus provided through the global financial crisis now a distant memory.

In May, official figures show retail sales fell 0.6 per cent with the annual growth rate dropping to 1.4 per cent, below the rate of inflation.

In the face of uncertainty, specialty retailers, who sell mostly discretionary items, put on a brave face but that has only lasted for so long thanks to rising costs, competition from online retail and a cautious consumer.

Department store
David Jones
flagged last week that it had downgraded its earnings.

Country Road
also announced a 10.9 per cent dip in Australian sales over the 2011 financial year in comparable stores blaming “difficult trading conditions".

What this means for shopping centre owners remains to be seen, but when David Jones dropped the bombshell about its earnings downgrade it had an immediate effect to two of Australia’s biggest retail landlords.

Westfield
and
CFS Retail
Property Trust watched as their shares dropped 2.3 per cent and 1.7 per cent, respectively.

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Clearly investors are worried, as shopping centre owners – both listed and private – have many of their malls book-ended by a David Jones or
Myer
, with their retail mixes heavily weighted towards fashion.

Retail expert Michael Baker says the mall’s dependency on fashion retail is an “issue". “Shopping centres have a long history of being able to evolve and adapt," he says.

“The difference now mainly is they’ve never had to reduce their dependence on fashion."

But these landlords are constantly looking to rearrange the retail offering, introducing cinemas and entertainment precincts, outdoor recreational areas and community services such as libraries.

What they are doing, however, is distancing themselves from the department stores. “If you look back 10 or 15 years ago, we really did look at department stores as the anchors to our shopping centres. It’s been evolving and we don’t see them as much of an anchor as they used to be," GPT Group’s head of retail, Brett Williams, says.

“You’ve got a lot a powerful retailers that are starting to take a lot of sales away from them . . . You look at some of these international entrants in the market and they become anchors in themselves."

Williams says GPT has been “getting a lot of interest" from international retailers. “You’ve heard about Apple [and] Gap. . . Now we’ve got Zara and Topshop that are talking to us. All these retailers want to be in big quality regional shopping centres," he says.

“The retail mix in some of our big regional [shopping centres] may change. The international retailers do take up far bigger stores and in turn that may impact some of the other fashion mix that goes alongside them."

Urbis director Simon Rumbold says his property consulting firm is dealing with most of the major shopping centres, providing guidance on where malls are headed – particularly in the face of online retailing. The web has become a big shopping mall for many price-conscious consumers.

“You need to keep diversifying these centres, bringing them up to date, changing the [retail] mix to suit the shoppers so you’re not just reliant on one or two categories. And that’s what they’re doing," he says.

“They need to keep up to date with it. This is not something where you can just sit on hands and watch the world go by. You need to be very active with intense management, more so over next decade than last decade because online retail is unquestionably creating the next round of challenges for shopping centres to figure out: “OK, what do we do with this?".

Just this week, Burnside Village – a sub-regional shopping centre in Adelaide owned by the Cohen Group – secured Spanish retailing giant Zara as its anchor tenant, with no department store in sight.

“Who wouldn’t want Zara in their shopping centre?" Cohen Group’s general manager of retail, Lyn Gray, says. While David Jones would have fitted Burnside Village’s demographic, Gray says the shopping centre wanted a “point of difference".

“Because there’s not that extra experience in there it doesn’t differentiate it from shopping over the net or shopping with some other retailer," he says.

Shopping centre owners have to “focus on the whole experience of a shopping centre," Hynes argues.

“How we make it easy for consumers. How we actually have a mix that differentiates us from the next, people can’t buy that experience. And we up the game on our customer service."

He brands Zara a breath of fresh air for Australian consumers.

“Zara is great example where Australian consumers are sick of the ‘sale mode’ and the ‘vanilla aspect’ to Australian retailing. Zara opens up and it’s an absolute overnight success while other retailers are struggling. It’s very simple. They’re fashion forward, they change their product every six weeks, they are very good quality price points," Hynes says.

Baker says the story of department stores over the past 15 years is one of “structural decline, consolidation and some degree of cyclical recovery".

“I have long said and written that department stores are very deeply flawed and a fundamentally obsolete retail format," Baker says.

“Anchor tenants driving traffic has been the underlying principle [for shopping centres] ever since they were invented. The anchors don’t pay as much rent because they support the smaller tenants. . . But when the anchors aren’t doing that any more, you know the model no longer works."

Supermarkets and discount department stores such as Target, Kmart or Big W are expected to continue to drive traffic.

“But the problem with the department store model, [shopping centre owners] are very exposed," he says.

“The options [for landlords] are not that great but they could get better. We have junior anchors coming in from overseas that are going to fill some of that space."

However not all malls are created equal. Baker says big retailers such as Zara, Topshop or Forever 21 will generally only be anchors in larger, regional shopping centres.

“It’ll be harder to do that in the marginal shopping centres because [fast-fashion retailers] won’t want to go there," he says.

The super regional malls such as Chadstone in Melbourne or the new Westfield Sydney have historically been considered the most resilient type of centre.

“We believe both international and domestic retailers will be focused on the most productive shopping malls," CLSA analyst John Kim says.

“These strong centres will get stronger, as tenants will pay a premium to be in higher-traffic centres."

But after analysing the sector and meeting with industry sources, Kim concludes that regional and sub-regional malls with below-average productivity will be “more vulnerable".

The Australian shopping mall industry has historically been “incredibly resilient", he says, largely because of high barriers of entry.

However, Deutsche Bank analysts say the risk to retail property incomes lies in the level of rent achieved on renewed leases, potential occupancy declines, which may also be driven by tenant failure, and the potential for development projects to fall short of targets.

Rumbold says that in 1994, department stores took up about 37 per cent of shopping centres. Today, they take up 22 per cent.

“Shopping centres have already done a lot of reinventing. Department stores have stayed the same but the centres have expanded around them," Rumbold says.

The reinvention of shopping malls started in the mid-90s with the introduction of cinemas, leisure precincts and food courts.

“Shopping centres have much less reliance on any individual tenant, even the major department stores, than they did in the past. They’re much more diverse places, which of course de-risks them as an investment," Rumbold says.

Landlords still need “destination tenants" – stores that draw a consumer to your shopping centre. But what is considered a destination tenant is changing.

“It used to be the department stores. . . They still generate traffic, don’t get me wrong. But as the centres expand you actually need more than that. We’ve been though discount department stores. We’ve been through supermarkets. Now we’re in the era of the mini-major – the
JB Hi-Fi
and Apple store," Rumbold says.

“We’re seeing JBs and Apples trading at higher numbers than discount department stores or even department stores in some cases. We’re generating a whole new paradigm of what retailing is as the market evolves."